Which Type of Crowdfunding Should You Choose for Your Business?
Crowdfunding is getting a lot of press lately and it should. It's turning into an accepted process to raise money for an idea, product, or entire business. Entrepreneurs now have crowdfunding as a finance option when they're thinking about financing their business. Crowdfunding can be a complement or substitute for traditional forms of financing, like angel investing, venture capital, and bank loans.
But with different flavors of crowdfunding to choose from, which is the right one for an entrepreneur to choose? That's the subject we'll explore in this article.
What Kind of Crowdfunding Is Right for My Business?
It's important to understand that there are various kinds of crowdfunding and each comes with its own strengths. We'll look at each type of crowdfunding, define how it works, and see if it's a good match for your business.
To get a business off the ground or to provide it with capital to really grow, entrepreneurs have typically turned to outside investors. In this scenario, they sell off a piece of their business to an investor (or group of investors) in return for their capital. Crowdfunding has its own version of this type of financing: equity crowdfunding. In this model, investors can invest as little as $500 sometimes to buy a small share in a business. Companies like AngelList, OurCrowd, Seedrs, and others are the leaders in this space.
- Larger amounts of money: When compared to other forms of crowdfunding, equity crowdfunding has the potential to raise larger sums of money. While that doesn't always happen, the individual checks investors can write can dwarf the small transactions seen in other forms of financing, like reward-based crowdfunding, for example.
- One customer/investor: If you can go out and raise $1 million from 100 investors outside of crowdfunding, you're going to have 100 people telling you what to do. Some of them will have great advice; others won't. When you raise this amount of money via crowdfunding, the crowdfunding platforms typically consolidate all the investors and their money into one entity. This means you only have one investor to communicate with and one investor on your capitalization table.
- Not viral: Right now, for a variety of reasons including a US regulatory system that hasn't fully embraced crowdfunding, there isn't really a large, hungry crowd of investors scouring crowdfunding platforms, looking for the latest and greatest company to fund. It's harder to get traction with an equity crowdfunding platforms.
- You're selling off part of your company: There's a saying that it's typically better to own a smaller stake in a larger company than a large one in a smaller enterprise but this is a personal decision. Do you want outside investors?
If you're familiar with Kickstarter or Indiegogo than you should have an idea what rewards-based crowdfunding is all about. In this model, an entrepreneur creates a crowdfunding campaign to raise money for a product that many times no more than just an idea.
Contributors to these campaigns typically get to pre-purchase the product at advantageous prices.
- "Cheap money": In rewards-based crowdfunding, you're not selling part of your business -- you're bringing in early fans and customers. That doesn't mean that this is easy money -- you'll still need to create the product and ship it to potentially thousands of awaiting crowdfunding backers.
- It's about more than the money: Many businesses turn to rewards-crowdfunding not just because it has proven to be an efficient way to fundraise a new product or business line. It also builds rabid fans, people who are excited to be an early supporter of your business. Established companies are turning to crowdfunding to test products with their audience to see if they'll be successful when they launch.
- Success can be your downfall: We're reading about more and more crowdfunding campaigns that raised millions of dollars and went bankrupt. How does that happen? Well, for one, raising the money is just the first part of a rewards-crowdfunding campaign. You still have to manufacture and ship a product. That has proven REALLY tricky for some startup and early-stage companies.
Individuals have turned to crowdfunding to skirt banks and borrow money to pay off things like their credit cards or to redo their kitchens. Peer to peer lending (now called, marketplace lending) is now embracing some small businesses who are turning to sites like LendingClub to take out business loans.
- Better than banks (sometimes): With peer to peer lending, this form of crowdfunding can beat interest rates at banks. Additionally, businesses that may have a hard time getting a loan at a bank can find success with crowdfunding. Sometimes. It's still early and just because it can work for your business doesn't mean there is someone out there willing to lend you money.
- More debt: Marketplace lending is just that...lending. That means you have another loan you need to repay. You may get favorable rates but you'll still need to pay off this loan.
If you're a non-profit, you've got your own form of crowdfunding. This doesn't require giving any rewards away (like you do with rewards-based crowdfunding). Donation-based crowdfunding is the online way to give -- non-profits run crowdfunding campaigns, they get shared among interested donors, and you raise money. Here are the best crowdfunding sites for charities and non-profits.
So, there you have it. Crowdfunding comes in a variety of different flavors, each with their own pros and cons. Which one are you going to choose?